3. You have been asked to analyze whether Telco Inc, a computer manufacturer, should invest in producing new software. Telco has already spent $ 2 million developing pieces of the software; this expense was capitalized and will be depreciated straight line over the next four years. - Telco will have to invest an additional $ 5 million if it wants to commercially develop the software, and this investment will also be depreciated straight line over four years to a salvage value of $ 1 million at the end of the 4th year. Based upon a market study, Telco concludes that it can generate revenues of $ 6 million every year for the next 4 years, operating expenses (other than depreciation) are expected to be 60% of revenues each year. Telco does not expect its overall annual G&A expenses, which are $5 million, currently to change as a result of investing in the software business, but it plans to allocate 10% of these expenses to this project. - Telco has an unlevered beta of 0.90 (bottom-up beta for computer manufacturers) but the unlevered beta for computer software companies is 1.50. The market value of equity for Telco is $ 80 million and the market value of debt is $ 20 million. Telco plans to maintain this debt to capital ratio for this project. Telco is BBB rated and the default spread on BBB rated bonds is 2% The riskless rate is 5% and the equity risk premium is 4%. The tax rate is 40% 1. Estimate the cost of capital for this project